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The strip strategy is a modified, and a more bearish version of the straddle strategy. It involves buying a particular number of At-the-money calls and twice the number of puts.
We must remember that the Calls and Puts must be of the same underlying stock, strike price and expiration date.
Let’s know how do we construct a Strip Strategy:
1. Buy 1 Call AT-THE-MONEY (ATM)
2. Buy 2 Puts AT-THE-MONEY (ATM)
We use this strategy when we expect volatility to increase in the near future and market direction to be on the bearish side. Large profit is attainable with the strip strategy when the underlying stock price makes a strong move either upwards or downwards at expiration, but gains are made faster and larger if the movement of the underlying is on the downside. The risk is limited to the net premium paid for the position and the maximum profit is unlimited.
Consider Maruti Futures which is trading at Rs 6000. We Buy a Call of 6000 strike price @ ₹100 and simultaneously buy 2 puts of strike 6000 @ ₹100 each. Both Calls and Puts should be of the same expiry date.
1C+ @ 6000 = 100
2P+ @ 6000 = 100
Maximum Profit : Unlimited
Maximum Loss : Limited to the net Premium Paid = 300
Lower Break-even Point = Strike price – (net premium paid/2) = 6000 - (300/2) = 5850
Upper Break-even Point = Strike price + net premium paid = 6000 + 300 = 6300
The Volatility should increase after devising the strategy to generate positive payoffs.